The U.S. Trade Deficit: What’s Next?

No aspect of American trade is talked about more and understood less than the trade deficit of the United States. However despite that, the U.S. trade deficit has almost nothing to do with trade policy. A nation’s trade deficit is determined by the flow of investment capital into or out of the country. And those flows are determined by how much the people of a nation save and invest – two variables that are only marginally affected by trade policy.

Throughout the 1990s and early 2000s corporations left at an incredible rate in search of cheaper labor, also as a result of increased taxes and regulations, something that occurs to this day.

Recently there have been numerous politically motivated speeches and accusations against certain nations for being “currency manipulators” or for stealing American jobs. Those accusations are simplistic and overlook one very important factor. America, over the past decade alone, has produced on a historical basis the greatest amount of national debt as it has throughout its almost 250 year existence. In other words, the United States exports the US Dollar (debt) and imports everything else.

What Is The Balance Of Trade?

Countries exchange goods and service across borders all the time. For instance, Saudi Arabia has some of the world’s largest oil reserves. Saudi Arabia is also a dessert climate with lots of sand. Drilling through sand to get to oil is not nearly as difficult as drilling through shale rock, such as what is found in Pennsylvania and New York. Because of the ease of which Saudi Arabia can drill for their oil, it is less expensive for them to obtain it. However, that sandy desert environment makes it difficult to grow wheat, for instance.

When you think of growing wheat in the United States there are a few states that might pop into your mind, Iowa, Kansas and Wisconsin, to name a few. However, when you think of oil, those three states do not readily cross your mind. There is some oil in those states but the amounts are low and it is difficult and costly to obtain. Enter the phrase: specialization and trade. Saudi Arabia can specialize in pumping oil and many states in the United States can specialize in producing base food commodities such as wheat, cattle and eggs. Then, trade ensues between the two nations.

But, if the United States consumes $1,000.00 worth of oil from the desert nation, but Saudi Arabia consumes only $900.00 worth of US food products, then there is an imbalance in the trade; the United States has a $100.00 trade deficit with Saudi Arabia, or in other words, has consumed more than it has produced.

How To Solve The US Trade Deficit?

The gateway to trade with a country is their currency. If you want to buy Saudi Arabian oil and you are in Saudi Arabia you must first purchase their currency, the Saudi Arabian Riyal. In the case of the United States Dollar, which is a worldwide reserve currency and as such is used globally to price and be used as the medium of exchange between countries.

And, if Saudi Arabia wants to bake some bread using wheat supplied from the United States, they need to exchange their Riyals for Dollars. But, in the oil for bread example, what happens with the excess $100 dollars that Saudi Arabia has accumulated?

If Saudis have too many dollars, they can get rid of dollars by purchasing goods with those dollars abroad, or simply selling dollars in exchange for other currencies, such as the Saudi Arabian Riyal.

In theory, any imbalance of trade would correct itself simply because of currency exchange rates. But, that is only ivory-tower theory. There is something else going on that is never accounted for in the trade deficit of the United States, and it is this: Have you ever heard of Chinese or [substitute any nationality]investing into the United States economy by purchasing assets such as real estate in the United States?

America has the world’s largest economy. Along with that economic strength are investment opportunities that less developed countries lack. As a result all of those extra dollars that pile up overseas in the form of government reserves accumulated from having a positive trade balance are invested back into the United States. This keeps the exchange rate from ‘correcting’ itself and continues the appreciation of the dollar as the economy continues to grow and prices of assets continue to rise as a result of foreign investment of trade surplus dollars into the US economy. Along the way, a Saudi prince becomes wealthy in Saudi Arabia as well as the United States.

What Happens When The US Loses It’s Only Net Export

Saudi Arabia’s economy is strongly tied to the oil industry; it is their #1 produced product. However, if your economy is tied to only one asset, such as oil, what happens to your country’s wealth if the price of oil drops? As economic growth is slowing there becomes less investment into the economy from investors. Less investment capital creates a snowball effect whereby people begin losing their jobs, and thus slowly (or quickly) the economy grinds to a halt.

In this example, the Saudi currency, the Riyal, would decline in value as the growth prospects of the Saudi economy would decline. However what happens when the United States’ #1 export, the US dollar (debt), declines in value and loses demand from overseas?

Firstly, lets examine briefly why someone would stop investing into the US economy. As with the example mentioning other countries, if economic growth prospects are bleak, then the appetite of investors to take on risk in the form of investing into components of the US economy would decrease. With a decrease in investment capital, people begin losing jobs, and so on and so forth the snow ball effect begins. Additionally, with a slowing economy, there would be decreased demand for US dollars (debt) which retains its value as a function of economic growth. If the economy is not growing, the value of the currency declines with it – all else being equal.

If the value of the US dollar decreases as a function of declining worldwide demand for it, that is the same thing as if the price of oil declines for Saudi Arabia. In short, its devastating. A decline in economic growth, recession or depression would not only force the unemployment rate higher, but would also undoubtedly lead to a decline in the value of the US Dollar, and with it, a decline in the purchasing power of the currency in your wallet.

Is The United States Wealthy With This Trade Deficit?

This is why you should stop paying attention to the ever increasing Dow Jones Industrial Average, which is comprised of only 30 publicly traded companies, as a determination into the health of the US economy. Instead, follow the debt, or in this case the US Dollar.

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